Higher Interest Rates Stall Global Growth

Bloomberg Business News

WASHINGTON _ Higher interest rates have put the brakes on the worldwide economic expansion, bringing slower growth to Europe and sparking fears of recession in the U.S.

Meanwhile, the appreciation of the yen has darkened the outlook in Japan, threatening to halt the short-lived recovery there, while a mountain of non-performing loans still on banks' accounts has financial markets nervous.

Central banks around the globe are likely to cut interest rates during the next two quarters to help boost flagging growth, analysts said.

"The economic environment points toward lower real interest rates and provides room for monetary easing in many of the G-7 nations," said a commentary by economists at NationsBanc Capital Markets Inc.

In the U.S., economic growth slowed to 2.7 percent in the first quarter of 1995 after running at a 4.1 percent rate for all of last year, as consumer demand cooled after the Federal Reserve's raised interest rates seven times in 12 months. Many economists say the U.S. economy barely grew, and may even have contracted, during the April-June quarter.

The U.S. economy's slowdown from last year's best-in-a-decade showing has been more pronounced than most economists expected, raising fears the economy will slip into recession later in the year. The U.S. economy shed a total of 108,000 jobs during April and May.

Still, many analysts say the fundamentals of the U.S. economy are strong enough so that consumer demand could bounce back during the second half.

European economies are also pinning their future hopes on stepped-up consumer activity.

"Companies in Europe are capitalizing on high profits and low wages _ they are financing investment," said Steve Englander, European economist at Smith Barney Inc. in Paris. "In 1995, investment will be the locomotive of the European economy."

Nevertheless, "in 1996, the consumer will need to kick in if the expansion is to endure," he said.

Economists say that growth in Europe already has begun to falter as earlier surges in production pile up unsold goods on warehouse shelves _ reflecting the reluctance of consumers to participate in this latest expansion.

Partly as a result, concern over rising German interest rates has evaporated. Indeed the Bundesbank, Germany's central bank, chopped its leading discount rate by a half point to 4 percent on March 30, and another reduction is expected.

Canada's economy has also slowed down considerably since its heady growth in 1994, when its 4.5 percent increase in the output of goods and services led the G-7 nations.

An expansion centered on exports of raw materials, cars and consumer goods has begun to sputter as economic growth in the first quarter rose at a 0.7 percent annualized rate, Statistics Canada figures showed. Slower demand in the U.S. _ destination of more than 80 percent of all exports _ is at fault, analysts said.

Domestic demand isn't offsetting the weak trade performance, as Canadians are holding on to their wallets and refusing to spend on big-ticket items. The combination of weaker demand at home and across the border has economists forecasting that economic output declined at a 1 to 2 percent annualized rate in the second quarter.

However, economists said that an easing of rates by the U.S. Federal Reserve would be quickly mimicked by the Bank of Canada, bringing new life into Canada's economy by year-end.

The Bank of Japan says its mid-April cut in the discount rate to an all-time low of 1 percent will support the economy. Already, some business leaders and economists are calling for another rate cut.

The central bank "facing deflation and a collapsing banking industry, must lower real interest rates and steepen the yield curve," said analysts at NationsBanc.

Prices for everything from laundry detergent to automobile parts in Japan are falling, driven down by weak demand, deregulation and competition from cheaper imports. While deflation is a boon to Japan's consumers, it is crimping corporate sales growth and pinching profits.

Also weighing on Japan's economy is the mountain of non-performing loans still on banks' accounts. The 21 largest banks have at least $476 billion in outstanding loans, much of which was lent to real estate speculators in the late 1980s. Banking analysts say the true amount may be much higher.

This load hurts the economy by restraining banks from extending new financing and keeping land prices down.

On June 8, the Ministry of Finance came out with measures to bolster deposit insurance, increase disclosure in the financial system and ease mergers between banks, clearing the way for eventual bank failures.

Markets, however, were not impressed. Investors said the measures didn't get directly at reducing the bad debt burden.

"The equity market has passed judgment on the economy and on policy," said Donald Kimball, an economist at Mitsubishi Bank. "We're concerned that the economy is indeed stalling."

The strong yen, which hurts exporters' profits, is already putting pressure on segments of the economy. Industrial production has started to fall, and manufacturers project further declines through June. To make up for lost profit margins, manufacturers will likely step up cost-cutting, trim labor forces and reduce investment in equipment, offices and factories.

Concern about wage growth and job security in Japan is going to make consumers spend less and save more. That will push up inventory levels.

Already, Japan's jobless rate has risen to a record 3.2 percent, and economists say it will keep climbing as the high yen forces companies to cut unproductive workers. And falling prices, driven lower by the strong yen, weak demand and deregulation, will further crimp company revenues.

In the U.S., where employers are already shedding jobs, the Federal Reserve has yet to cut rates. That may be only a matter of time, though, since consumers show few signs of opening their wallets any time soon.

Still, analysts said central bankers are loath to lower the overnight bank lending rate and then have to raise it again if stronger growth rekindles inflation in the late summer and fall.

The key for the Fed is "tolerance," said Jerry Zukowski, an economist with PaineWebber in New York. "How long can they tolerate weaker numbers?" Quite a while, said many analysts _ unless the government reports early next month that employment took another big dive in June.

Nevertheless, Fed Chairman Alan Greenspan recently sparked hopes the Fed will cut interest rates when he said that an acceleration in inflation in early 1995 is a natural "afterglow" of the economy's rapid expansion last year, and that forces driving U.S. inflation "are very clearly easing."

In remarks to the Economic Club of New York, Greenspan said he sees an increased chance of a "modest near-term recession," though the chances of a severe downturn have been "markedly reduced" because companies aren't stuck with swollen inventories to be liquidated as the economy slows." more

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